Are Default 401(k) Savings Rates Too Low?

By Anne Tergesen

By one measure, automatic enrollment has been a smashing success: It has boosted employee participation rates in 401(k) plans above 85%, compared with 67% for those plans without auto-enrollment, Aon Hewitt says.

But because two-thirds of companies set the default contribution rates at 3% of salary or less, the new trend hasn’t done much to help participants achieve the 12% to 15% annual savings rates they will need if they are going to amass an adequate retirement nest egg.

Why do most employees choose a default savings rate of just 3%? Many worry that if they go much higher, employees will start dropping out of the plan. But new evidence from New York Life Insurance Co.’s 401(k) administration unit indicates otherwise.

According to a recent study by New York Life’s Retirement Plan Services division, “higher default deferral rates in 401(k) plans with auto enrollment lead to higher participant retention.” New York Life examined 480 of the plans it administers, with a collective total of 800,000 participants. Over the 12 months that ended on March 31, those plans with default rates of 3% or less had a 14% drop-out rate, on average. In contrast, in plans with a default savings rates above 3%, the average drop-out rate was 10%.

In addition, 30% of participants enrolled in plans with default savings rates above 3% voluntarily elected to raise their savings rates within a year of enrollment, up from only 13% who did so in 2006. By contrast, in plans with default savings rates of 3% or less, 27% voluntarily raised their savings rates—about the same as the 26% who did so in 2006.

The net effect, says David Castellani, CEO of New York Life Retirement Plan Services, is that “as account balances grow, so does the level of engagement of participants” in the plan. “We see it not just in savings rates, but also in hits on plan web sites and participants’ action around investment allocations,” he says. Higher default savings rates “create a greater participant engagement level.”

For that reason, he adds, “we encourage our (plan) sponsors not only to auto-enroll, but to push the auto-enrollment envelope as far as they can,” by implementing higher default savings rates.

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Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.